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Getting Testy About Worker Misclassification

Employers big and small have been facing a rising tide of wage-hour lawsuits over the past 10-15 years, and there is currently no end in sight. This dramatic increase can be seen in the chart below which tracks the number of lawsuits filed under the Fair Labor Standards Act (the FLSA), the federal wage-hour law that covers most employers.

Creative attorneys continue to come up with an ever-expanding menu of new legal theories and claims, including challenges to long-accepted practices that are only now beginning to be questioned; cities and states are passing “wage theft prevention” laws and increasing penalties and liquidated damages to successful litigants; and the US Department of Labor (the DOL) has been particularly active in the past year, issuing guidance on independent contractors and joint employers, and proposing revisions to the minimum salary level for employees classified as “exempt” from overtime. Moreover, it is not just big employers that need to worry about their wage practices. Many smaller companies, non-profit organizations, and even individual employers have been caught up in lawsuits and government investigations or enforcement actions.

The consequences of making a mistake as to how or whether employees are paid; how their pay is calculated; whether an employee is entitled to overtime; or whether someone is properly classified as an independent contractor, an intern, or a volunteer are significant. Liability could include unpaid wages, liquidated damages (up to 300% in some places), attorneys’ fees, civil and criminal penalties, government investigations and audits, back taxes, bad publicity, and more.

Thus, while it is of course critical for employers to carefully review and revise policies and practices, conduct internal audits, train managers, improve recordkeeping, keep up with legal and legislative developments, and involve legal counsel, it is also important for every employer - including small organizations and household or individual employers - to have at least a basic understanding of some of the more significant wage-hour laws and issues that they will likely confront at one time or another. We have tried to capture some of these issues, along with common misconceptions, in the below True-False quiz. Feel free to play along at home.

1. The FLSA does not apply to me because I only employ 2 or 3 workers in my house.

False. The FLSA is the federal law which sets minimum wage, overtime, and recordkeeping standards. It applies to most employment situations, including: (i) businesses or organizations (“enterprises”) with at least two employees and at least US$500,000 in annual sales or business; (ii) hospitals, businesses providing medical or nursing care for residents, schools and preschools, and government agencies; (iii) employees who are engaged in commerce or in the production of goods for commerce (even if their employer is not covered as an “enterprise”); and (iv) domestic service workers.

Under the FLSA, a domestic service worker is someone who provides services of a household nature in or about a private home. Such workers include, but are not limited to, companions, babysitters, cooks, waiters, maids, housekeepers, nannies, nurses, janitors, caretakers, handymen, gardeners, home health aides, personal care aides, and family chauffeurs. A private home is one that is owned or rented, and occupied by a family, and may be a fixed place of living or a temporary residence, such as when a family travels on vacation.

2. Salaried employees do not have to be paid overtime.

False. While it is true that, for most employees, being paid on a “salary basis” (a predetermined and guaranteed salary that, for the most part, is not subject to partial-day or partial-week deductions) is a pre-requisite for exemption from overtime, a salary alone does not make someone automatically exempt from overtime. In addition to being paid on a salary basis, employees must also fall within one of several exemptions based on their “primary” job duty. This is even true for highly paid employees. The most common exemptions are part of the so-called “white collar exemptions” from overtime, and include the executive, administrative, learned professional, creative professional, outside salesperson, and computer professional exemptions.

Thus, an employee’s exemption from or entitlement to overtime will typically turn not on their salary, but on what their actual duties and responsibilities are.

Fun fact - the current minimum salary threshold for qualifying for most exemptions from overtime is currently US$455 per week, or US$23,660 per year. In other words, most employees earning less than US$23,660 per year are entitled to overtime as a matter of law, regardless of their actual duties. Last year, the DOL issued new proposed regulations that would raise the minimum salary threshold to a projected US$970 per week, or US$50,400 per year, with automatic adjustments each year based on various labor benchmarks or inflation. The final regulations are expected to be issued this summer, and could go into effect by the end of the year. Employers should therefore look carefully at any employees earning less than US$50,400 who are classified as exempt, in order to determine whether to raise their salary, convert them to overtime-eligible, change their job duties, or carefully control their hours going forward.

3. There is no “black and white” test for determining an employee’s eligibility for overtime.

True (sort of). Of course, as noted above, there are a series of tests for determining if an employee is entitled to or “exempt” from overtime under the FLSA. And these tests are, in fact, written down in various federal regulations, as well as in guidance and opinion letters from the DOL and court decisions interpreting those rules and regulations. Some aspects of these tests are even black and white! However, as anyone who has ever tried to actually apply any of these tests knows, an employee’s entitlement to overtime typically falls within a vast gray area.

For example, to fall within the Administrative exemption - the most common of the “white collar” exemptions - an employee must: (i) meet the salary basis test; (ii) have a primary duty of performing office or non-manual work directly related to management policies or general business operations; and (iii) exercise discretion and independent judgment with respect to matters of significance. But what does this mean exactly?

An employee’s “primary duty” is their most important duty, but does not necessarily mean the duty they perform the most. Work “directly related to management policies or general business operations” generally means work performed in functional areas such as tax, finance, accounting or budgeting, auditing, insurance, quality control, purchasing, public relations, legal or regulatory compliance, advertising, marketing, research, safety and health, or human resources, among others. “Discretion and independent judgment” - an amorphous term if ever there was one, typically involves the comparison and evaluation of possible courses of conduct and making a decision after the various possibilities have been considered, as well as having the authority to make an independent choice free from immediate supervision. “Matters of significance” typically include some aspect of affecting, interpreting, or implementing management policies; carrying out major assignments in conducting business operations; performing work that affects business operations to a substantial degree; planning long- or short-term business strategies or objectives; committing the employer to significant financial matters; negotiating and binding the company on significant matters; or providing consultation or expert advice to management.

One can easily conclude that certain clerical and entry-level positions are entitled to overtime because they do not require a significant amount of discretion and independent judgment, particularly with respect to department or company-wide policies or strategies. And similarly, one can easily conclude that certain high-level executives (but not at the “c-suite” level) who may not oversee a department but nevertheless play a large role in decision-making and operations are exempt from overtime. But what about everyone else?

4. There are many different tests for determining whether someone is an independent contractor or an employee.

True. Believe it or not, there is no single test that allows an employer to quickly or easily determine whether someone can/should be hired as an independent contractor/consultant/ freelancer (paid on a 1099 basis) or should be treated as an employee. Rather, there are different tests applied by different federal agencies and under different federal laws, not to mention different state tests as well. These tests may be called the “economic realities” test, the “right to control” test, the “ABC” test, the “IRS” test, or even the “hybrid” test. And, someone could theoretically be an independent contractor according to the IRS, an employee for purposes of the FLSA and federal wage-hour law, an employee for purposes of state unemployment insurance, and an independent contractor for purposes of Title VII.

What is important to keep in mind, however, is that these tests - and most federal and state laws and agencies - take the position that individual workers are, by default, employees. The burden, therefore, is on each employing or contracting entity to prove otherwise, and there can be significant adverse consequences when someone has been misclassified.

Significantly, while the legal framework is certainly a mess, most of the tests are actually somewhat similar. Important factors typically include: (i) the nature and degree of control exercised or retained by the employer (does the employer control the manner and means by which the worker performs their work?); (ii) the worker’s opportunity for profit or loss; (iii) the worker’s investment in facilities and equipment; (iv) the level of special skills and initiative required for the job; (v) the permanency of the relationship; and (vi) whether the worker’s services are integral to the company. Other factors to consider include whether the worker holds themselves out as an independent business (do they have their own business cards or advertising presence; do they work for multiple companies, including competitors; do they provide their own equipment); does the contractor set the rate of pay/is there an arms’ length negotiation over the terms of compensation (or is it set by the employing entity); are there set hours of work; does the worker work side by side with employees performing similar work; is the worker supervised or is she generally free from immediate direction; is the worker provided with a company email or phone number; and what do the governing documents and policies say?

Taken together, employers must exercise considerable caution before hiring individuals as “contractors” and paying them on a 1099 basis, and should consider implementing screening measures to ensure that no one is hired as an independent contractor without first being carefully reviewed and approved by a trained human resources or legal professional.

4. Entering into an independent contractor agreement will typically protect an employer from a misclassification claim.

False. On the one hand, not having an independent contractor or consulting agreement in place is typically a red flag that someone may be misclassified. On the other hand, having a written agreement in place does not guarantee that the worker is properly classified either. In fact, a poorly drafted agreement (for example, one that provides for employee benefits or that grants significant control to the contracting entity over the services to be performed) can also doom an independent contractor relationship. Nevertheless, using a good independent contractor or consulting agreement is an important first step. Agreements should be reviewed carefully with legal counsel, should be negotiated and should be adaptable for different contractors/consultants, and should not contain provisions that treat the contractor like an employee (providing benefits, calling for training or supervision, requiring status reports, paying on an hourly rate as opposed to a project or other fee basis, providing for reimbursements for business expenses, etc.).

6. College interns do not need to be paid.

False. Federal law and most state laws are actually silent when it comes to whether or not “interns” are employees, and therefore have to be paid. It has thus been left to the courts and to different federal and state agencies to decide when interns are employees and must be paid. According to the DOL, interns are considered employees unless they meet a strict six-part test originally adopted for trainees. The DOL’s test can be met (and an internship unpaid), if the intern: (i) receives training similar to what would be given in an educational environment; (ii) the intern is the primary beneficiary of the internship; (iii) the intern does not displace any regular employees; (iv) the employer derives no immediate advantage from the intern; (v) the intern is not necessarily entitled to a job at the conclusion of the internship; and (vi) the employer and the intern understand that the intern is not entitled to wages.

Not surprisingly, under the DOL’s intern test, because all six factors must be met, almost all interns must be paid! However, several federal appeals courts have recently rejected the DOL’s rigid view of internships, and instead have recognized that the test should be more flexible and should focus on who the “primary beneficiary” of the internship actually is. These courts have looked at who benefits more from the internship, and have given significantly greater weight where the intern receives school credit, where the internship is part of a formal education program or a requirement for graduation, and where the internship provides actual training and beneficial learning to the intern. While for-profit employers proceed at their own risk if they wish to use unpaid interns, at a minimum, diligent employers will make sure that their interns receive school credit, are not performing similar work to employees, are being trained and provided with learning opportunities, participate in a formal or semi-formal internship program, and are engaging in work tied to their education.

What about not-for-profit organizations? Interestingly, there is nothing in the (federal) law that distinguishes between for-profit and non-profit employers. However, the DOL has declined to enforce the FLSA against non-profits as long as their (unpaid) interns are engaging in charitable, religious, educational, or civic work. Many states treat non-profit interns the same way. The District of Columbia, for example, recognizes an exception for non-profit entities that use interns. To be safe, however, even non-profit organizations should strive to meet as many of the DOL’s six factors as possible (or in NY and Florida, ensure that the intern is the “primary beneficiary” of the relationship).

Compare jurisdictions: Employment: Canada

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